A recent article by Deloitte suggests a number of strategies that asset management companies need to adopt, if they are to rise above the challenges of current environment. Among those suggested include restructuring product portfolios, streamlining operations, and offering digital-inspired customer experiences — especially since Millennials comprise an increasingly-significant portion of the asset management marketplace.
Deloitte is dead on, in terms of the transformations that the asset management industry needs to embrace. Interestingly, the three changes they suggest are among the many solutions that a merger of blockchain and asset management can provide.
Also known as distributed ledger technology (DLT), blockchain admittedly brings both pluses and minuses to the table. As with every burgeoning technology, blockchain development solutions offer both new benefits, and a few new challenges of its own that we must overcome. As always, uncertainties and obstacles will resolve themselves, one way or another, and adoption will occur.
A Fair Overview of Blockchain in Asset Management
In this post, we take a broad view of how blockchain asset management solutions might be just what the industry needs, just when it needs them. We also look at a few of the challenges that the asset management industry and DLT technologists must work together to overcome.
Whether we are talking about asset management, or the broader category of managed financial services, wealth management, the concepts we will discuss generally apply to both. As for physical asset management, DLT has applications there, too, although we may reserve those for a future conversation.
To answer a question that many asset managers may already be asking, yes, disruption will occur. The idea that blockchain will not only benefit the asset management industry, but will also mean obsolescence for certain intermediary roles, is rightfully troubling for some. However, those impacted must not confuse obsolescence with extinction. The asset management business is all about making the most of opportunities, and those whose roles will evaporate will simply find new opportunities to serve their clients within the expansive blockchain-asset management ecosystem.
Advantages of Blockchain for Asset Management
It is a foolish question to ask if blockchain is the next “big thing” in asset management. It is — end of debate. The question we should focus on, instead, is what can DLT do for the industry?
Glad you asked.
At the top of the list of what blockchain offers asset management is improved data security. Actually, DLT does more than improve the privacy and security of data, it completely transforms how data is stored and accessed.
In a manner unique to all conventional security methodologies, blockchain software offers not only security, but an immutable record of all transactions. By distributing records across multiple nodes, the odds of a data breach on a central database are eliminated.
Since DLT involves grouping transactions into blocks of data, encrypting the data blocks, and linking each data block to all those before it and all those to follow, data tampering becomes a near impossibility. In order to manipulate a financial record without detection, a hacker would have to simultaneously make the same change in all data blocks. Doing so would mean having access to all of the private and public keys, and access to all of the nodes comprising the blockchain. In a phrase, not going to happen.
Not only is blockchain technology secure, it can be fast. A properly-designed asset management blockchain can provide near-real-time performance in asset tracking, giving managers quick insights into data drift and changes that can affect their clients’ portfolios.
Increased Operational Efficiency
On first thought, you might wonder how replicating a database across multiple nodes can result in higher efficiency than can be achieved with one central database.
Although improving the speed at which data is acted upon has a direct bearing on operational efficiency, it is not the primary factor. The benefit to efficiency primarily comes from the blockchain structure.
As we mentioned, a blockchain is a database that is copied across multiple nodes. Those nodes are, first of all, simply computer systems. But since the nodes on which a blockchain exists are computers operated by all of the various institutions that are party to the asset management industry, the exchange of data between institutions can occur almost instantly. In effect, rather than one institution having to send information to another, they simply update their own records. The blockchain backbone does the rest, automatically validating the change and updating the records on all other nodes to match.
The distributed structure of DLT offers an exponential increase in speed for B2B transactions within the asset management industry.
In the highly-regulated asset management industry, merely onboarding new clients is a time-consuming chore. Validating client identification, asset ownership, wealth sources, marital status, occupation, political ties, business interests, and citizenship can take days or even weeks.
While blockchain does not inherently expedite these processes, it provides the structure for development of solutions that can do so. With blockchain infrastructure nodes extending to the proper institutions, fast and permissioned access to the required information will become as commonplace as modern credit checks.
No single asset management company or technology provider can provide such a solution, but working together, stakeholders can build infrastructures that facilitate the fast sharing of information needed to reduce the onboarding process to an inconsequential time frame.
Streamlining Portfolio Management
Portfolios built on blockchain technology benefit from the highly organized data structures DLT provides. Whatever protocols the industry ultimately adopts, DLT will accelerate communications between investors, asset managers, and third-party entities.
Clearance and Settling of Trades
Inefficiency in the current trading infrastructure limits clearance and settling of trades to two or three days. Since a completion of a blockchain transaction requires approval from all involved parties, DLT can eliminate the difference between a trade and the clearing of the transaction. This also eliminates counterparty risk, and improves capital availability.
Eventually, we could see blockchains replace Automated Clearinghouse (ACH) and Automated Customer Account transfer (ACAT) systems as the technology matures.
As we shall see in a moment, ensuring that blockchain asset management platforms are regulatory compliant poses some challenges, but for now let’s look at the other side of that coin.
Key to satisfying the ever-increasing burden to comply with government and industry regulations are three main factors: speed, transparency, and traceability. The structure of DLT inherently facilitates all three.
Since each blockchain transaction is verified by all vested parties, meeting compliance demands becomes easier. Further, the immutability of DLT makes creating audit trails a thing of the past. Every data block becomes part of the audit trail, providing not only a transaction’s financial details, but also marking each with an unalterable date and time stamp, and a digital signature.
Last in our list, but likely #1 in terms of what makes DLT exciting for the financial sector, is the use of smart contracts.
Smart contracts are nothing more than relatively short blocks of code that automate certain tasks. In asset management, those tasks can be anything from automatically triggering the sale of a fund, based on rules set by the client, to fulfilling the actual execution of a contract between the client and the asset manager. In short, smart contracts eliminate the need for attorneys in certain situations, while making contract and rule-based executions automatic and nearly instantaneous.
Challenges of Adopting Blockchain for Asset Management
Despite the wealth of benefits DLT offers the asset and wealth management industry, it is not without its problems. Some of the challenges that will slow adoption are technological, some are regulatory, and some are simply psychological in nature.
Here is our list of the top challenges that must be overcome before DLT can raise its flag on the asset management hill.
Lack Of Market Familiarity
Risk is not foreign to asset managers. In many ways, it is reason they have a job. If there were no risks in the management of financial assets, there would be little need for experts to manage portfolios. On the other hand, when risks affect their career viability, they are understandably less enthusiastic about accepting them. And so it is with blockchain.
The reluctance of many within the financial sector to embrace DLT is based on a lack of knowledge of how it can benefit them and their clients. Are there downsides and even risks to transitioning to a blockchain platform? Definitely. Will there be losses along the way? We can count on it. But the benefits of improved security, faster transactions, improved operational efficiency, and reduced compliance burdens immeasurably outweighs the risks of implementation.
Hopefully, articles such as this, and increased uses cases, will help to make industry decision makers more comfortable embracing the DLT solutions that are headed their way.
Limited History Processing Large Volumes Of Data
Blockchain technology has proven to be faster, more robust, and more flexible than many legacy systems. However, critics argue that DLT has yet to be tested on applications where billions of transactions must be handled with a high degree of reliability and security. DLT is especially untested in applications where dramatic and non-linear increases in data volume can be experienced.
Bitcoin? Not even. The Bitcoin blockchain can achieve only seven transactions per second, while Visa blazes along at more than 24,000 per second.
Since the Bitcoin blockchain only processes bitcoin transactions, it is unfair to compare it with Ethereum, which can host virtually any type of blockchain. However, even with Etherum’s open source platform, there is yet to appear a blockchain that can match Visa’s volume reliably.
This is not not say that DLT cannot accommodate the speeds and reliability necessary for the financial sector, only that it has yet to be demonstrated.
Lack Of Experience In Smart Contract Security
To date, there has been no verifiable breach of a major blockchain backbone. However, the short road from DLT concept to adoption has already been littered with examples of fraud resulting from deficiencies in smart contract coding or third-party applications.
Critics argue that the significant losses experienced so far are reason enough to delay broadscale adoption by financial sectors. There may always be vulnerabilities in third-party components of the blockchain ecosystem. However, security is in the best interest of large-scale providers of enterprise DLT platforms, such as IMB and Amazon Web Services, so they will invest whatever it takes to keep their platforms secure.
Blockchain makes it easier to satisfy regulatory compliance demands. Even regulators, themselves, encourage the exploration of DLT for financial services. At the same time, distributed ledgers do not always lend themselves to meeting the regulations designed for siloed systems.
In order for DLT to satisfy regulators, technology providers, the financial industry as a whole, and government entities must work together to arrive at workable solutions. Since regulators are not experts on the technology, and technology providers are not experts on regulatory requirements, financial institutions may find themselves at the crossroads unless cooperation occurs on a grand scale.
High Cost To Replace Legacy Systems And Processes
Blockchain promises/threatens to bring about rapid and radical changes to the venerable financial institutions upon which we have come to rely. How rapid and how radical the transformation may be is limited, in part, by the cost of implementation.
Although transition can and must proceed cautiously and through sensible proof-of-concept models, at some point heavy investment is necessary to pave the pathway for full adoption.
Planning to meet these cost challenges is difficult when an institution, or an industry, is on uncharted ground. Overcoming cost-factor concerns will pose a challenge until sufficient use cases emerge. Once a sufficient amount of data is in, it will be easier for decision makers to assess the cost of adoption, and to plan for it.
Road to Adoption for Asset Management Blockchains
The road to broad adoption across the asset management sector will include a process similar to the following:
- Consortium efforts involving government regulators, financial institutions, and technology providers
- POC testing of blockchain models
- Industry adoption DLT technology standards
- Interoperability with legacy systems
- Successful uses cases
- Proof of scalability
- Proof of security hardness
Experts suggest, further, that institutions begin by applying blockchain technology to internal, back-office processes before attempting large-scale implementation on public-facing systems.
How Ignite Can Help
Meeting the challenges of blockchain adoption will be no small undertaking, It requires partnering with technology providers who know how to bridge siloed systems with DLT platforms that are secure, compliant, and scaleable. Ignite is such a partner.
We offer outsource solutions for today’s cutting-edge technologies, including blockchain, mobile apps, fintech, and cloud-based platforms. With six R&D labs across Western Europe, we are equipped to develop your DLT solution.
Why not contact us today for a no-cost consultation?